Capital investment decision is taking place on a regular basis, and therefore it’s important for an organization to identify its project requirements to set a proper track for future business growth. This decision isn’t as easy or as clear as it might sound. There’s lots at stake, and the long term financial impact might be unknown because of… asymmetry in risk/reward profile. In order to deal with the investment decision and its related uncertainties, several investment decision techniques are applied in the context of the investment decision.
There are three investment decision techniques that are usually applied in the investment decision making process: earnings, value creation, and retained earnings. The firm decides whether to generate new assets or to sell its existing assets for short term investment decision purposes. The investment decision in financial management deals with firms’ ability to create new jobs, increase production, maximize pricing and reduce costs. The firm decides whether to add jobs, invest in new equipment, or reduce costs by means of salary reductions, quality improvements, inventory re-furnishment, or selling products.
The investment decision in financial management considers the price of assets, the firm’s balance sheet, and the firm’s income statement. These decisions are based on information obtained from the firm’s existing assets, liabilities, revenues, and assets and liabilities. There are many factors that influence the cost and type of equity financing required by a firm. The investment decision in financial management is also affected by decisions regarding the mix of long term investments; debt and equity financing; and, availability of credit.
One of the main investment decision techniques that managers apply is the asset mix method. This method places a priority on certain assets over other assets to determine the size and growth rate of a firm’s assets. This means that managers seek to gain access to a number of good investments while still keeping costs low. Other measures used to evaluate a firm’s potentials include market and economic studies as well as management policies. By making decisions based on these criteria, managers attempt to increase the value of the total assets of the firm while at the same time reducing costs. This form of investment decision making involves weighing investments against potentials.
The third major area that managers make investment decision based on financial statements is through the use of working capital management decision. This involves the determination of a firm’s sources of cash flow and its capability to repay short-term debts. Through this decision, managers attempt to determine if the current assets of the firm can meet the demands of short-term financing needs. Examples of working capital management decisions include:
Capital Budgeting Techniques: Capital budgeting techniques are primarily used in determining investment decision making. These techniques involve the allocation of resources (i.e., investment dollars) to various projects and goals. Capital budgeting techniques also involves determining the timing and magnitude of projects, assessing the risks associated with projects, estimating potential costs and benefits, estimating the effect of trade-offs among alternatives, planning for the gradual or abrupt changes in allocations, analyzing and identifying trends or patterns in project developments, analyzing the performance of a firm’s capital structure, evaluating the interrelationship between capital budgeting techniques and operational indicators, and developing an investment strategy based on this information. These techniques help managers make investment decision based on future expectations. The four major elements of this technique include the identification and measurement of funding need, the allocation of funds to projects, the timing and magnitude of projects, the identification and evaluation of risks associated with projects, and the planning and implementation of a sound capital budgeting plan.
Dividend Reinvestment Strategies: During times when market prices are falling, most financial decisions are affected by the dividend received by the corporation. A dividend is a payment made by the Board of Directors to the shareholders. Normally, companies with the best management are able to withstand short-term market fluctuations because the income earned from dividends is used for growth purposes. If the company is able to sustain its dividend payments, it can offset the loss incurred due to market fluctuations and thus result in positive cash flow. In order to have stable cash flow, companies use dividend reinvestment strategies.
Risk Involved Approach: In investment decision making, managers consider both short-term and long-term factors. The long-term factors usually involve the viability of the business, its ability to generate profits, and its potential for generating future profits. A company’s credit ratings, assets, liabilities, ownership structure, etc. play an important role in determining the investment decision making process. Taking all these factors into consideration, managers come up with an investment decision that is in accordance with the long-term goal of the organization.